Balance of Payments

Introduction
• Balance of Payments (BoP) refers to the recording
of all transactions of a given country with rest of
the world.
• Ordinarily , a country has to deal with other
countries in respect of three items namely:-
i) Visible Items- All Types of Physical Goods Exported
& imported
ii) Invisible Items – All those services whose export and
import are not visible
iii) Capital Transfers- Concerned with capital receipts
and capital payments.
Definition
“ The balance of payment of country is a systematic
record of all economic transactions between its
residents & residents of foreign countries.”
Kindleberger
“ The balance of payments is a summary record of all
economic transactions between residents of one
country and the rest of the world during a given
period of time.” James O Ingram
Features of Balance of Payments
1. Systematic Record
2. Fixed Period of Time
3. Comprehensiveness
4. Double Entry System
5. Self-balanced
6. Adjustment of Differences
7. All items-Government and Non Government
 Balance of Trade and Balance of Payments –
A Comparative Study
Balance of Trade
Balance of trade of a country is relation over period
between the values of her exports and the value
of her imports.
Three kinds of Balance of Trade
Surplus or Favourable Balance of Trade
i. Deficit or Unfavourable Balance of Trade
ii. Equilibrium in Balance of Trade
Differences Between Balance of Trade and Balance of Payments
Balance of Trade
1. Includes Imports & Exports
of goods alone
2. Can be favourable or
unfavourable
3. Deficit of Balance of Trade
can be met by balance of
payments
4. Insignificant from the point
of view of economic analysis
5. A narrow concept; forms
part of Balance of Payments
Balance of Payments
1. Includes Imports and Exports
of goods services and capital
2. Always Balances
3. Deficit of balance of
payments cannot be met by
balance of trade
4. Significant from the point of
view of economic analysis.
5. Broad Term which includes
Balance of Trade.
 Structure of Balance of Payments
Balance of Payments

Items Receipts Payments or Debit Net (+) or (-)

 Forms of Balance of Payments
• Current Account
 BoP on current account is a settlement of actual receipts and payments in short period.
 Includes the value of imports and exports of both visible and visible items.
 Current account transactions are called account by actual transactions, because all items included
in it are actually transacted, these items have a direct effect on the income,output and employment
of a country’s economy.
Balance pf Payment on Current Account = (Visible + Invisible Exports)-
(Visible + Invisible Imports)

• Capital Account
 Refers to capital Transactions
 All kind of short-term and long term international capital transfers, movement of gold, payments
on private account, payments and receipts on national institutional account,and government loans,
interest, grants, etc. are included in this account
 All transactions under capital account are concerned merely with financial transfers, as such , they
have no direct effect on the income, output and employment of a country’s economy.

• Over all Balance of Payments

 Total of country’s current account and capital account is reflected in overall balance of payments
 It is always in balance; because the deficit or surplus of current account is set off by capital
account and that of capital account is set off by current account
 Methods to Measure Balance of Payments
• Basic Balance
Basic balance comprises of current balance of payments and long-
period capital balance of payments
• Net Liquidity Balance
In this account are included : basic balance and short period private
illiquid capital balance.
• Official Settlement Balance
It includes gross liquid balance short period private liquid capital
balance.
Balance of Payments has two main parts
• Current Account
• Capital Account
 Components or Items of Current Account
 Export and Import of Visible Goods
 Invisible Items- Services
• Services rendered by Commercial Undertakings
• Services of Experts
• Travelling-Business, Education, Health, Conventions,
Pleasure Trips
• Transportation
• Investment Income
• Governmental Transactions
• Donations and Gifts
• Miscellaneous
Major Items: Capital Account
• Private Foreign Loan Flow
• Movement in Banking Capital
• Official Capital Transactions
• Reserves, Monetary Gold and SDR
• Gold Movement
• Miscellaneous
 Balance of Payments Always Balances
1. Balance of Payments in Accounting Sense
2. Balance of Payments in Operational Sense
Disequilibrium in Balance of Payments
1. Balanced Balance of Payments:
When total receipts of a country or exports ( visible and invisible) are equal to its
total payments or imports (visible and invisible) then its balance payments is in
balance.
B=R–P=O
2. Favourable Balance of Payments:
In order to balance the receipts and payments, a country receives gold from
abroad or it has to give short term loans, then its receipts are more than payments
and balance of payments turns favourable.
BF = R – P > O
3. Unfavourable Balance of Payments
Balance of Payments is unfavourable when to balance its receipts and payments,
a country has either to give gold or indulge in short – term borrowing from
abroad.
Bu=R–P<O
 Types of Disequilibrium
1. Cyclical Disequilibrium
2. Secular Disequilibrium
3. Structural Disequilibrium
4. Fundamental Disequilibrium
5. Temporary Equilibrium
Causes of Disequilibrium in Balance of Payments
1. Natural Causes
2. Economic Causes
i. Economic Development Plans
ii. Price-Cost Effect
iii. Cylindrical Fluctuations
iv. Change in Foreign Exchange Rates
v. Decline in Foreign Demand
vi. Change in Terms of Trade
vii. Demonstration Effect
viii. Population Explosion
ix. Foreign Capital Investment Flow
x. International Economic Practices and Policies
3. Political Factors
i. Expansion of Embassies and their Maintenance
ii. Political Instability
iii. International Relation
iv. Partition or Unification of a country
Results or Effects of Adverse Balance of Payments
1. It lowers the international economic credibility of the
country
2. Economic dependence of the country on foreign
countries increases
3. Country’s economy is subjected to exploitation
4. Foreign exchange reserves of the country are depleted
5. Reserves of gold and other precious metals go down as
the same flow out of the country
6. Foreign dependence sometimes assumes the form of
political dependence
7. Pace of economic development of the country slows
down
8. Foreign interference in country’s economic social and
political spheres goes on increasing.
 Measures to Correct Adverse Balance of Payments
Or
Methods of Correcting Disequilibrium in BoP

1. Economic Measures
2. Political Measures
3. Social Measures
4. International Measures
1. Economic Measures to Correct Disequilibrium in BoP
a. Monetary Measures
b. Non-Monetary Measures
Monetary Measures
i. Deflation
ii. Devaluation
iii. Exchange Depreciation
iv. Exchange Control
v. External Debts
Non Monetary Measures
1. Discouraging Imports
i. Import Duties
ii. Import Quotas
iii. Encouraging Import Substitutions
2. Export Promotion
3. Encouragement to Foreign Investment
4. Attraction to Foreign Tourists
5. Liberal Industrial Policy
6. State Trading
2. Political Measures
i. Less Expenses on Embassies
ii. End of Political Alliances
iii. Political and Administrative Thriftiness
iv. Changes in Basic Political Ideology
v. Participation of Non-Residents
3. Social Measures
BoP can be corrected through the medium of social
Psychology.
4. International Measures
Formation of new regional or international alliances or
market organisations or participation in the existing
organisation can help to reduce adverse balance of
payments. SAARC, NAM, EEC, WTO, UNCTAD etc.
are the examples of such alliances.
 Importance of Balance of Payments
1. Guide to Economic Conditions and Direction
2. Pictogram of Economic Changes
3. Indicator of Foreign Changes
4. Indicator of Foreign Dependency
5. Knowledge of Foreign Investment
6. Indicator of Foreign Trade
7. Helpful in National Planning
8. Determinant of National Economic Policy
9. Helpful for International Financial Organisations
 Effect of Devaluation on Balance of Payments
1. No increase in Prices of Exports
2. Demand for Imports must be Highly Elastic

R
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P
E
E
S

IMPORTS

i. Elastic Demand of imports

ii. Inelastic Demand of Imports
3. Demand for Exports should be highly Elastic

D
O
L
L
A
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EXPORTS

i. Inelastic Demand for Exports

ii. Elastic Demand Curve for Exports
4. Adequate Availability of export goods
5. International Cooperation
6. Possibility of Import Substitution
7. Importance of Foreign Trade in the country’s
Economy